Budget likely to be supportive of bond market: Neeraj Gambhir

The 10-year bond yield might be volatile in the near-term, but Neeraj Gambhir , managing director and head of fixed income (India) at Nomura Fixed Income Securities, believes by end-2014, it shall be at 8.50 per cent. He talks to Neelasri Barman about the Reserve Bank of India’s (RBI) policy stance, fiscal consolidation for the government and the risk management strategy of primary dealers. Edited excerpts:

Of late, bond yields have become quite volatile due to the Iraq crisis. Do you see the 10-year bond yield touching nine per cent soon?

We saw a rally in the bond market after the election results. The flows in bonds market from foreign institutional investors were pretty good. The data has been reasonably supportive. But the rally got interrupted due to crude oil prices and the geo-political tensions. Now, the market is focusing a lot more on the crude oil prices and its impact on the domestic economy. I feel, we are near the top end of the range for bond yields. The Budget is likely to be supportive of the bond market and we should see some cooling in bond yields. The near-term range till the Budget for the 10-year yield is expected to be 8.50-8.75 per cent. This is for the existing 10-year benchmark bond. Our house forecast for 10-year bond yield is around 8.50 per cent by the end of this calendar year.

Do you think the Iraq crisis will put pressure on inflation and RBI will again take a hawkish stance in the August policy review?

Inflation is pretty much on the expected trajectory. The focus is on keeping the Consumer Price Index (CPI) inflation at eight per cent by January 2015, as per the Urjit Patel committee report. We expect RBI will be able to meet that target. If we see an uptick in food prices as a result of poor monsoon, then we will have to see how the government manages the situation. Barring that, inflation is pretty much under control. The tone of the next RBI policy will be highly dependent on the measures that we see in the Budget, both on the supply-side and on the fiscal consolidations. If there is evidence that the government is serious about containing inflation by addressing some of the long-term supply-side issues, then RBI might go a tad soft on the monetary policy stance. I do not expect a rate cut over the next six to eight months. RBI will look to cut rates only if they think that inflation expectations have come down and also the forward path of inflation is significantly lower than the target of six per cent until January 2016.

It is believed RBI and the government are working towards a plan to make payments for oil to Iraq. Would RBI end up mopping dollars from the market despite weakness in the rupee?

The oil payments are a regular payment in terms of our balance of payments flows. It doesn’t matter whether we buy it from Iraq or some other supplier. The overall intervention strategy of RBI is driven by a few other considerations as well. There is a significantly large amount of forward liabilities in RBI’s balance sheet due to foreign currency non-resident bank deposits or FCNR(B) swaps. This needs to be addressed. However, RBI has slightly less than three years to cover that liability. If the flows continue to be good and the rupee is under appreciation pressure, RBI will likely continue its interventions to add to the reserves. First, for addressing forward liabilities and then for adding to net reserves. However, they may not intervene at every price level.

Do you think the fiscal deficit shall be contained at 4.1 per cent of gross domestic product (GDP) for the current financial year?

There is an expectation in the market that there may be a wider fiscal deficit for this fiscal (FY15), given the government will try and address the subsidy issue and non-payments in the past. I do expect the Budget to talk a strong language of fiscal consolidation. They might highlight the fact that we cannot afford to have the right level of growth unless there is fiscal consolidation. Bringing the fiscal deficit to a three per cent level, as highlighted by the Fiscal Responsibility and Budget Management Act, should be talked about. The market will be sensitive about the kind of borrowing the government will do. The market has probably factored in Rs 25,000-30,000 crore of additional borrowing in the current financial year. The fiscal deficit for FY15 may be between 4.3 per cent and 4.5 per cent of the GDP.

RBI is planning to make changes in CPI-linked inflation index bonds. Can you suggest some changes that will make these bonds work?

This product is relatively new and complex to understand. It will take time to grow. There needs to be a proper push by banks and distributors. There is need for a better incentive structure for distributors to push this product. Some tax incentives should also be thought about to popularise this product with retail investors.

In times like these when bond yields are volatile, what strategy can be adopted for primary dealers like you?

Our business is highly dependent on bond yields. Risk management is a strong aspect from business point. The more volatile the market, the more important is the risk management. So, the focus on that is extremely crucial. Other things include growing client business and ensuring the franchise is strong enough to help us meet statutory obligations with minimal negative impact on balance sheet.